Following the surprise result of France's general election on Sunday, one thing is clear: If President Emmanuel Macron forms a new government, it will face months of political paralysis. What's unclear is whether the impasse will further strain France's highly indebted economy.
The turmoil has put renewed spotlight on France's ballooning debt of 3 trillion euros and a budget deficit that has widened to more than 5% of economic output, prompting ratings agency Standard & Poor's to issue an immediate warning on France's sovereign rating on Monday.
“Uncertainty surrounds France's future government structure,” the agency said. It had already downgraded France's debt rating on May 31, unsettling a government whose economic credentials are one of its main political assets. France's debt rating could be downgraded again if polarization in France's new parliament weakens the government's ability to consolidate its finances, it added.
France is facing uncharted territory after left-wing parties made unexpected gains in national elections, beating the nationalist, anti-immigration National Rally party to the top of the lower house. The result was that no party, including Macron's centrist coalition, won a majority and the lower house was split into three bitterly divided factions.
The French economy was already in a tough spot. Unemployment, which fell to a 15-year low of 7 percent last year, is rising again as manufacturers cut production and exports slow. Consumers, weary of stubborn inflation, are cutting back on spending that drives growth.
Macron's government recently warned that growth this year will be weaker than expected and is considering spending cuts of more than 20 billion euros ($21.5 billion). The European Union scolded France late last month for violating fiscal rules that limit spending and borrowing. France's debt has risen to more than 110% of economic output and it is running a deep budget deficit after the government spent heavily to protect consumers and businesses from pandemic lockdowns and soaring energy prices.
Macron's opponents on the right and left used the debt issue to attack him during the election, but the major parties show no signs of reaching an agreement, and investors worry the new parliament will be unable to pass a budget in the autumn that would include deep spending cuts and avoid the risk of further downgrades to France's debt.
“Once the dust settles, the deadlock in the hanging parliament will be more damaging than initially anticipated,” Alex Everett, investment manager at London-based investment firm Abledon, wrote in a client note. “France's budget problems are not resolved, and Macron's attempts to force unity are only creating more discord.”
Investors were already pushing up government borrowing costs. The gap between the interest rates investors are charging on French bonds and German rates has widened to its widest since the financial crisis, signaling investors are worried about France's ability to manage its finances. The risk is that France's debt could balloon further, accelerating the rise in interest payments.
Complicating the situation is the New Popular Front, a left-wing coalition that won the most seats in the lower house on Sunday. The coalition, which includes Communist, Green and Socialist lawmakers, is pushing a heavy “tax the rich and distribute the wealth” agenda inspired by the far-left France Indomitable party, and has said it is willing to ignore European Union fiscal rules if necessary to implement its policies.
Indeed, unless the government raises taxes on corporations and the wealthy, leftists are likely to reject a national budget that respects France's commitments to the EU and debt-rating agencies to cut the budget deficit to 4.4% of GDP from 5.1% next year, Mujtaba Rahman, Eurasia Group's European managing director, said in an analysis. The group would also call for more spending on education and health care and could push for an increase in France's minimum wage, he said.
But while the left is emboldened, it lacks overall control and its policies are unlikely to be approved, easing some investor concerns about the economic cost of the New Popular Front's spending plans, estimated at 187 billion euros per year, to be paid for by 150 billion euros in tax hikes on corporations and the wealthy and by eliminating various corporate tax cuts.
“A hung parliament would likely be the best solution for European stock markets,” said Claudia Panseri, chief investment officer for France at UBS Global Wealth Management.
Macron's finance minister, Bruno Le Maire, warned in a post on X on Monday that the left-wing coalition's economic policies could plunge France into financial crisis and economic decline. “It would undo the achievements of the policies we have pursued for seven years, which have given France jobs, charm and factories,” he said.
Holger Schmieding, chief economist at Berenberg Bank, said the legislative deadlock “would mean the end of Macron's pro-growth reforms.” Instead, he said, Macron's center-right coalition would probably have to accept reversing some of its signature policies, including his plan to raise France's retirement age from 62 to 64, which sparked nationwide demonstrations in 2022.
In the longer term, such policy reversals and global investor unpopularity would likely slow French growth and boost inflation, Schmieding added. “Combined with a possible credit rating downgrade, this would raise financing costs and exacerbate France's fiscal difficulties,” he said.
